Bernanke sees important risks in wholesale funding markets

Tracking risk is essential for the Fed as it pushes down long-term bond yields through monthly purchases of $85 billion in Treasuries and mortgage-backed securities.

The Treasury 10-year note yielded 1.86% at 10:00 a.m. in New York trading, an increase from a 2013 low of 1.62% on May 2. The Standard and Poor’s 500 stock index has increased 14.4% this year compared with a 14.0% gain for the KBW Bank Index, which includes 24 large financial institutions such as Bank of America Corp. The S&P 500 rose 0.3% to 1,631.30.

The Federal Open Market Committee has considered whether bond purchases aimed at fueling economic growth and reducing 7.5% unemployment will distort asset prices and disrupt markets. The buying has pushed up the Fed’s balance sheet to $3.32 trillion.

“Asset purchases were seen by some as having a potential to contribute to imbalances in financial markets and asset prices, which could undermine financial stability over time,” according to minutes of the March 19-20 FOMC meeting.

Deflating Bubbles

Policy makers are also debating what tools to use in deflating asset price bubbles. Fed Governor Jeremy Stein in February said he saw circumstances “where it might make sense to enlist monetary policy” to curb excessive risk-taking because interest rates influence corners of the financial system unreachable through bank regulation.

Minneapolis Fed president Narayana Kocherlakota said in April that Fed efforts to ensure stable prices and reduce unemployment will probably warrant a long period of low interest rates that will inflate asset prices.

“Even in the presence of effective supervision and regulation, these phenomena could pose residual macroeconomic risks,” he said.